Ch 7 - federal tax considerations
Which of the following could initiate the Accelerated Benefits Provision or Rider of a life policy? A A total disability not reducing life expectancy B A presumptive disability C Inability to perform some activities of daily living D A condition that is terminal
A condition that is terminal --- The qualifying event in the Living Needs rider is the terminal status of the insured (i.e. projected to die within 1 or 2 years).
All employer-paid premiums for amounts above $_________ of group life insurance are reported as taxable income to the employee. A $25,000 B $75,000 C $50,000 D $100,000
$50,000
Employer-paid premiums for employee group term life do not constitute taxable income to the employee for coverage up to ___________. A $30,000 B $40,000 C $25,000 D $50,000
$50,000 --- Employer-paid group life insurance premiums for coverage up to $50,000 are not taxable as income to the employee.
Non-Qualified Plans
Nonqualified Plans Employee contributions paid with after-tax dollars (not tax-deductible) Upon withdrawal, only the earnings are taxable Usually not funded by the employer until the employee actually retires
taxable
Taxable Interest received from a life insurance death benefit settlement option Withdrawals, cash surrenders, and policy loans distributed from a MEC up to an amount equal to the earnings Interest earned on policy dividends Death benefits included in an insured's estate Life insurance cash withdrawals or surrenders that exceed the cost basis
If an annuity is annuitized, then the _________ investment is recovered income tax-free over the income benefit payment period. A After-tax B Exclusion C Pre-tax D Non-guaranteed
After-tax ---- Only the after-tax investment is recovered income tax-free from an annuity that is annuitized. It represents a return of the cost basis.
H has an annuity funded with pre-tax dollars. So far H has placed $10,000 into the policy and it is now worth $25,000. If H cashes out the annuity, how much is taxable? A $15,000 B $25,000 C $10,000 D Zero
$25,000 --- Since the contributions are pre-tax and the earnings are tax-deferred, the entire amount is taxable upon withdrawal.
Life insurance will be considered 'incidental' to a qualified plan if the insurance amount is not more than ________ times the expected monthly benefit amount. A 100 B 150 C 200 D 250
100 -- Generally, life insurance will be considered 'incidental' to a qualified plan if no more than 50% of the contributions are used to pay insurance premiums, and the insurance amount is not more than 100 times the expected monthly benefit amount.
To qualify for a tax-free accelerated death benefit, the insured must be given a prognosis of how many months or less life expectancy? A 12 B 24 C 36 D 6
24 -------- Federal law establishes 24 months as a person's maximum life expectancy to be defined as terminally ill. For the activation of an accelerated death benefit rider, and for the purpose of limiting such claims, insurance companies often define terminal illness as one which would result in death within 12 months.
When a life insurance policy does not pass the ______-pay test, it becomes classified as a MEC. A 7 B 8 C 9 D 10
7 --- It is the 7-pay test that must be passed in order not to be classified as a MEC.
Which of the following statements about Section 1035 transactions is TRUE? A Any surrender charges satisfied on the old policy carry over into the new policy B All surrender charges are waived on any existing policy C A 1035 allows an annuity to be exchanged for life insurance D A new application is required when moving into a new life insurance policy
A new application is required when moving into a new life insurance policy --- If an existing policy has a surrender charge, it is still applied. The new policy requires evidence of insurability, and new surrender charges will apply to the new policy if it has them.
The exception to the rule concerning the non-deductibility of life insurance premiums is: A Key Employee Insurance B Life insurance to fund a Buy-Sell Agreement C Third-Party Ownership Policies D All employer paid group life insurance premiums
All employer paid group life insurance premiums ------- An employer may deduct 100% of the total group life premium it pays as a business expense, but the value of premiums for any employee's coverage in excess of $50,000 must be 'imputed' to the employee and income tax paid on that amount.
All of the following tax-free exchanges of life insurance and annuities are permitted, EXCEPT ____________. A Life insurance to long term care insurance B Annuity to life insurance C Life insurance to an annuity D Annuity to long term care insurance
Annuity to life insurance
How are employer paid premiums on a group life insurance plan treated for tax purposes? A A barter transaction B As compensation in lieu of cash C As a personal expense paid on behalf of the employee D As an ordinary and necessary business expense
As an ordinary and necessary business expense --- Employer paid premiums on a group life insurance plan are treated as an ordinary and necessary business expense which is why it qualifies for tax deductibility.
When may an employer deduct the premiums it pays for an employee's life insurance benefit? A As long as the business does not derive a direct benefit from the policy B Employers can always deduct the premiums it pays for an employee's life insurance benefit C An employer cannot ever deduct premiums it pays for an employee's life insurance benefit D If the business does not receive more than 50% of the death benefit
As long as the business does not derive a direct benefit from the policy ----------- As long as the insurance death benefit is not payable to the employer when an employee dies, the premiums paid for the life insurance are deductible to the business.
All of the following statements about Group Life Insurance are true, except: A Employees receive a tax deduction for employer paid premiums B Employee paid premiums are not tax deductible C Employer paid premiums are tax deductible D Employees are taxed on any premiums paid on insurance in excess of $50,000
Employees receive a tax deduction for employer paid premiums --- Employer, not employee, paid premiums are tax deductible. Only when the insurance benefit exceeds $50,000 does the employee have to report it as taxable income.
When an annuitant annuitizes their annuity that has a cost basis in it, the amount of the income benefit payment subject to tax is determined by using the: A Annuity rule B Superannuation ratio C Exclusion ratio D Exception rule
Exclusion ratio ---- The exclusion ratio allows the annuitant to account for the cost basis overtime so that the initial payments are not 100% taxable until all cost basis has been fully accounted for.
When withdrawing cash from a cash value life insurance policy, the amount of the withdrawal up to the policy's cost basis is tax-free. This tax accounting rule is referred to as: A Last-In, First-Out (LIFO) B Dollar Cost Averaging C First-In, Still There (FIST) D First-In, First-Out (FIFO)
First-In, First-Out (FIFO)
When withdrawing cash from a cash value life insurance policy, the amount of the withdrawal up to the policy's cost basis is tax-free. This tax accounting rule is referred to as: A Last-In, First-Out (LIFO) B First-In, Still There (FIST) C Dollar Cost Averaging D First-In, First-Out (FIFO)
First-In, First-Out (FIFO) --- FIFO accounting is first-in, first-out, which is why the recovery of amounts up to the cost basis are income tax-free.
Which of the following best defines the 'Cost Recovery Rule'? A When a policy is surrendered, the earnings within the policy are accounted for first B Generally, the difference between the amount of cash value received and the amount of premium paid in is subject to income tax upon surrender C The earnings on the policy's cash values are taxed every year and build up a cost basis which is recovered income tax-free upon surrender D The amount of the policy's internal expenses plus the life producer's commission make up the total cost of the policy
Generally, the difference between the amount of cash value received and the amount of premium paid in is subject to income tax upon surrender --- The 'Cost Recovery Rule' stipulates that upon a partial withdrawal of cash or the surrender of a policy, the cash value in excess of premiums paid (cost basis) is subject to income tax.
Under what circumstance would a policy loan in a life insurance policy be taxable? A If the policy lapses or is surrendered, any loan amount in excess of cost basis is taxable B If the insured dies, the policy loan is taxable unless there is sufficient death benefit available to pay off the loan C If the policyowner dies, the policy loan becomes taxable D Policy loans in life insurance are always tax-free
If the policy lapses or is surrendered, any loan amount in excess of cost basis is taxable -------------------Policy loans and unpaid loan interest are subject to taxation if the loan amount exceeds the cost basis (the Cost Basis is the amount of premiums paid into the policy less any dividends or withdrawals previously taken) in the contract in the event the policy lapses or is surrendered for its cash value. Surrender charges, if any, may be applied as an offset to cost basis
During the accumulation phase of an annuity, if the contract owner dies and the annuitant is someone other than the owner, the value of the annuity is: A Included in the owner's estate for valuation B Paid out income tax-free to the beneficiary C Included in the beneficiary's estate for immediate estate taxation D 100% taxable to the beneficiary
Included in the owner's estate for valuation ---- During the accumulation phase, if the contract owner dies, the value of the annuity is included in the owner's estate for valuation.
Income-tax Free
Income-tax Free Policy loan from an in-force policy Group life insurance death benefit proceeds (lump sum) Policy dividend Qualified accelerated death benefit Lump sum death benefit paid to a beneficiary
The Modified Endowment Contract (MEC) rules were put into place because: A The federal government needed a new source of tax revenue B Too many consumers were being sold life insurance when they thought they were buying annuities C Individuals were overfunding life insurance policies and using them as tax-free investment vehicles instead of a way to protect survivors against the financial cost of one's death D Life insurance companies needed to become more competitive with other financial institutions
Individuals were overfunding life insurance policies and using them as tax-free investment vehicles instead of a way to protect survivors against the financial cost of one's death --- Prior to 1988, individuals were using life insurance policies in place of investment vehicles to avoid paying taxes.
Which of the following scenarios will trigger an income tax due? A Receiving a participating policy's cash dividend B Interest earned on dividends left on deposit with the insurer C Cancelling the policy during the free look period D Taking out a policy loan in an amount greater than the total premiums paid in
Interest earned on dividends left on deposit with the insurer ------- While the dividend is free from income tax the interest earned on the dividend is subject to tax.
If no beneficiary is living at the time of the insured's death, the benefit will automatically be paid __________. A Into the insured's estate B The deceased's spouse C To next of kin D The funeral home
Into the insured's estate --- The policyowner may name the estate as a beneficiary, or by default, if no beneficiary is living at the time of the insured's death, the benefit will automatically be paid into the insured's estate.
If no beneficiary is living at the time of the insured's death, the benefit will automatically be paid __________. A The deceased's spouse B To next of kin C The funeral home D Into the insured's estate
Into the insured's estate -----
Withdrawals from a non-qualified annuity that is not part of an annuitization are taxed on which of the following methods? A Cost basis identification B Last-in, first-out basis (LIFO) C First-in, last-out basis (FIFO) D Weighted average
Last-in, first-out basis (LIFO) --- A withdrawal is any amount distributed from the annuity that is not part of the annuitization process and will be taxed on a last-in, first-out basis (LIFO). That means for income tax purposes, the first money out of the annuity will be considered as earnings, not principal.
All of the following transactions qualify for IRC Section 1035 exchange tax treatment, except: A A life insurance policy may be exchanged for another life insurance policy B Nonqualified tax deferred annuities may be exchanged for life insurance policies C Life insurance may be exchanged for an annuity D A life insurance policy can be exchange for a long-term care policy
Nonqualified tax deferred annuities may be exchanged for life insurance policies --- IRS Section 1035 covers like kind exchanges of insurance contracts. Permitted exchanges include Life > Life, Life > Annuity, Annuity > Annuity. Life insurance or annuity contracts may also be exchanged for certain long-term care contracts.
All of the following transactions qualify for IRC Section 1035 exchange tax treatment, except: A Life insurance may be exchanged for an annuity B A life insurance policy can be exchange for a long-term care policy C Nonqualified tax deferred annuities may be exchanged for life insurance policies D A life insurance policy may be exchanged for another life insurance policy
Nonqualified tax deferred annuities may be exchanged for life insurance policies ------------ IRS Section 1035 covers like kind exchanges of insurance contracts. Permitted exchanges include Life > Life, Life > Annuity, Annuity > Annuity. Life insurance or annuity contracts may also be exchanged for certain long-term care contracts.
When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at _________ tax rates. A Short-term capital gain B Alternative Minimum Tax (AMT) C Long-term capital gain D Ordinary income
Ordinary income --- When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at ordinary income tax rates.
Qualified plans
Qualified Plans Contributions made by employee are tax-deductible or pre-tax Entire amount of withdrawal is taxable to the employee upon distribution Must meet ERISA minimum standards
Janelle is the beneficiary of a life insurance policy in which the insured has died. What is the only way she can receive the claim amount totally free from income taxes? A Elect the life only settlement option B Choose the interest income only settlement option C Receive the claim amount in a lump sum D Select the 10-year period certain settlement option
Receive the claim amount in a lump sum --- Any settlement option will generate taxable income to the beneficiary. The only way to be exempt from any income taxation is to receive the death benefit in a lump sum.
If Charlotte wishes to cash out her annuity at age 58 after having it for over 20 years, what should she know about prior to doing it? A She will have to pay tax penalties B She will face income tax consequences and tax penalties C She will pay surrender charges for failing to annuitize D She will have to pay income taxes
She will face income tax consequences and tax penalties --- Due to her age, she will face both income taxes and tax penalties.
If an annuitant withdraws funds from their annuity prior to age 59 1/2 what is the tax consequence? A Tax on the entire withdrawal plus a 10% tax penalty B Tax on cost basis and 10% tax penalty on the tax deferred portion of the withdrawal C Tax on the tax deferred portion of the withdrawal along with a 15% tax penalty D Tax and 10% penalty tax on the withdrawal that represents earnings
Tax and 10% penalty tax on the withdrawal that represents earnings --- The withdrawal that represents earnings will be taxed along with a 10% tax penalty.
A permanent policy is surrendered for its cash value, and that sum is greater than the amount of premiums paid in. How is the excess taxed? A Taxed as ordinary income B No tax is due C Taxed as a short term capital gain D Taxed as long term capital gain
Taxed as ordinary income ----------- Upon surrender, any equity (i.e., amount above total premiums paid) is taxed as ordinary income. The premiums paid are also referred to as 'cost basis.'
Joe had $500,000 of life insurance at work. He has an additional $40,000 life insurance policy the company purchased on all employees. His wife is the primary beneficiary and their four children are contingent beneficiaries. Upon Joe's death, what are the tax consequences to his beneficiaries? A The $40,000 will be taxed since the premium was tax-deductible by the employer B The $540,000 lump sum proceeds will be received income tax-free C All premiums paid may be deducted from the face value before taxation D $460,000 is income taxable to the recipient
The $540,000 lump sum proceeds will be received income tax-free --- The death benefit (face amount) of both individual and group policies received in a lump sum by a named beneficiary(s) is income tax-free.
To eliminate the use of life insurance as a short-term, tax-free savings vehicle, what tax law change took place? A The Modified Endowment Contract (MEC) rules were put into place B Employer-paid premiums were made non-tax-deductible C Loan interest became tax-deductible D Death benefits became income-taxable
The Modified Endowment Contract (MEC) rules were put into place
In the event that an insured receives a periodic benefit as the result of exercising the Accelerated Death Benefit Rider, what information must the insurer provide to the insured? A The life expectancy of the insured on a semi-annual basis B The amount of taxable income that they will be reporting to the IRS C The amount of the accelerated payment, the remaining death benefit and cash values D Verification and update of the policy ownership and beneficiary designations
The amount of the accelerated payment, the remaining death benefit and cash values --- The Accelerated Death Benefit Rider advances a terminally ill insured a portion of the death benefit.
Death benefits are paid to the estate of the policyowner/insured in which of the following situations? A The primary beneficiary is a minor B The beneficiary is the estate C The primary beneficiary is the deceased's spouse D The contingent beneficiary has outlived the primary beneficiary
The beneficiary is the estate
Death benefits are paid to the estate of the policyowner/insured in which of the following situations? A The contingent beneficiary has outlived the primary beneficiary B The primary beneficiary is the deceased's spouse C The primary beneficiary is a minor D The beneficiary is the estate
The beneficiary is the estate ----------- If the beneficiary is listed as the estate, then upon death of the insured that is where the funds will end up.
Under the Modified Endowment Contract rules the 7-Pay Test is defined as: A The comparison of premiums paid during the first 7 years with the net level premiums that would have been paid on a 7 year pay whole life of the same death benefit B Any life insurance policy that endows in 7 years C The least amount of premium required to be paid in the first 7 years to maintain the policy to age 70 D The cash value at the end of year 7 exceeds the total premiums paid
The comparison of premiums paid during the first 7 years with the net level premiums that would have been paid on a 7 year pay whole life of the same death benefit --- A MEC occurs at any time within the first seven years of a policy (or of a material change to a policy, such as a death benefit increase or decrease) if the sum of premiums paid exceeds the amount of premiums that would be paid in a 7-pay contract.
If dividends are left on deposit with an insurer to earn interest: A The dividend is tax-free, but the interest is taxable B The interest is tax-free as well as the dividend C The dividend is taxable, but the interest is tax-free D The dividend is taxable as well as the interest
The dividend is tax-free, but the interest is taxable --- Interest paid by insurers on dividends left on deposit is taxable as income.
Clayton is asking his life insurance producer about any potential taxation issues related to his $100,000 personal Whole Life policy. All of the following are TRUE, except: A Annual increases in the policy's cash value are not taxable at the time they are credited to the policy B The interest that he pays on policy loans is tax-deductible C Since his policy is a personal policy, he cannot deduct the premiums he pays for the policy D Upon surrender of the policy, he will be taxed on any amount by which the cash value exceeds the cost basis (premiums paid) of the contract
The interest that he pays on policy loans is tax-deductible --- The interest on policy loans is not tax-deductible.
Once a policy is classified as a MEC, it will maintain that classification for ____________. A Until the issue of overfunding is resolved B For 10 years C The life of the policy D For 7 years
The life of the policy ------- Once a policy is classified as a MEC, it will maintain that classification for the life of the policy.
If a life insurance policy becomes a MEC, what was the cause? A The policy was exchanged for an annuity B The policyowner stopped paying premiums after 7 years C The policy failed the 7-pay test D The policy was rolled over into an IRA
The policy failed the 7-pay test ------- A policy that does not pass the 7-Pay Test will be deemed a Modified Endowment Contract for the life of the contract.
H is employed by a company that provides group life insurance. The amount provided is $150,000. How much, if any, of the coverage is going to be reported as taxable income to H?H is employed by a company that provides group life insurance. How much of the employer-paid premiums for H's $150,000 coverage, if any, is going to be reported as taxable income to H? A The premium paid for $50,000 B The premium paid for $100,000 C Zero D The premium paid for $75,000
The premium paid for $100,000 --- Employer paid premiums in connection with group life insurance does not constitute taxable income to the employee unless the death benefit paid for by the employer exceeds $50,000. All employer paid premiums for amounts above $50,000 are reported as taxable income to the employee.
The life insurance policy cost basis consists of: A The cash value of the policy B The net amount at risk C The premiums paid in D The dividends received
The premiums paid in
The life insurance policy cost basis consists of: A The dividends received B The cash value of the policy C The premiums paid in D The net amount at risk
The premiums paid in --- The premiums paid establish a cost basis in the policy.
Which of the following is the reason why premiums paid on personal life insurance are not deductible? A They rarely exceed 10% of a taxpayer's AGI B It makes the deductibility of employer-paid premiums more attractive C They are considered to produce a guaranteed source of income D They are considered a personal expense
They are considered a personal expense --- For individuals, premiums are considered a personal expense and are not deductible. They are paid with after-tax dollars. This establishes a cost basis in the policy for tax purposes.
If money is paid when a change of ownership in a life insurance policy takes place, this is generally known as a ____________. A 1035 Exchange B Transfer for value C Viatical settlement D Life settlement
Transfer for value --- A transfer for value takes place when money is paid for a change in ownership.
All of the following are times in which life insurance policy cash values can become taxable, except: A When the policy is sold B When a policy loan is taken out C At policy surrender D If the policy fails to meet the IRS definition of life insurance
When a policy loan is taken out ----------- Policy loans do not trigger a taxable event.
Generally, life insurance death proceeds are income tax free to the policy beneficiary, except: A If the employer deducts the premiums on a group life insurance plan covering the employees B When the policy is classified as a MEC C When the death benefit option B is selected on a Variable Universal Life policy D When a transfer of ownership has taken place
When a transfer of ownership has taken place --- Life insurance proceeds are generally income tax free except when a transfer of ownership has taken place.
Unless an exception applies, life insurance proceeds are income taxable in which of the following circumstances? A When there is a change of beneficiary from a non-policyowner to the policyowner B When a policy is used for collateral for a bank loan C If a transfer of ownership occurs after the insured dies D When a transfer of ownership takes place while the insured was alive
When a transfer of ownership takes place while the insured was alive --- If a transfer of ownership takes place while the insured was alive the death benefit becomes income taxable unless an exception applies.